Bund yields jumped and the euro rallied on 6-7 June after Peter Praet, the normally dovish European Central Bank (ECB) chief economist, said that at next week’s meeting the Governing Council would assess whether a gradual unwinding of quantitative easing is warranted. Ten-year Bund yields rose 10 basis points, the second-biggest one-day jump this year, and the euro gained 0.9% versus the USD. It has appreciated 2.4% since its 29 May low.
We have a positive longer-term view on the euro, targeting EURUSD 1.30 over 12 months. But the ECB confirming its intention to unwind QE would be just one of the conditions we believe are required before EURUSD can resume a stable appreciation path.
- Greater political clarity in Italy. It appears the ECB is unlikely to be swayed from its path by political uncertainty in Italy, but this does not mean that volatility and potential pressure on the euro won’t continue near term. This week new Prime Minister Giuseppe Conte’s maiden speech outlined elements of the M5S-Lega coalition’s populist policy agenda, which unsettled Italian bond markets.
- More robust economic data. European economic data has been worse than expected this year and has yet to pick up materially. While still expanding, the pace of economic growth in the Eurozone softened further to an 18-month low in May, according to PMI data released this week.
- US 10-year yields remaining within recent ranges. Interest rate differentials have supported the USD versus the euro, but in our view most of the rise has already occurred.
We believe these conditions should be met over the balance of this year. We expect solid global growth to support Eurozone exports, don’t anticipate widespread contagion from Italian politics and believe the Federal Reserve will maintain its gradual tightening path.
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